NLCP - Cannabis REITs Have Gone To Pot

2023-06-27 07:00:00 ET

Summary

• I suspect my home state will be the last state legalizing pot.
• So the closest I can get to this polarizing sector is cannabis REITs.
• In this article, I break down the 5 cannabis REITs.

This article was published at iREIT® on Alpha on Saturday, June 24, 2023.

July 1 ^st is a big day in the State of Maryland. That’s when individuals 21 and older will be able to buy vapes, gummies, pre-rolled joints, edibles and more from about 100 dispensaries statewide.

Dispensaries are planning for a surge of customers in the state, as well as consumers in Virginia and Pennsylvania that don’t have recreational markets.

Voters in Maryland approved a referendum last November that essentially piggybacks on the existing medical cannabis laws which were legalized in 2014 (didn’t see its first sales until 2017). Maryland is expecting annual revenue from the cannabis industry to top $1.5 billion.

Cannabis laws are changing rapidly across all 50 states, and in order to keep up with the laws, DISA has provided this ( interactive ) map below for information on legitimatization, medical use, recreational use, and anything in between.

As you can see, South Carolina (my home state) is one of the last remaining holdouts (along with Kansas, Wyoming, and Idaho).

According to Forbes , South Carolina Representative, Nancy Mace, is “on a mission to legalize cannabis.”

“There's a million reasons to end federal prohibition and the only place where this is controversial is up here. It’s an enormously popular idea. America is like: ‘WTF, D.C., why have you not done this yet?’”

Mace, who I know very well, has one of the most powerful conservative groups in the world in her corner, according to Forbes:

“Charles Koch’s Americans for Prosperity. And now she has one of the world’s largest companies supporting her bill: Amazon ( AMZN ).

Amazon does not want to sell cannabis, it is employment they are after, as “ it opens up the hiring pool by about 10% ", according to Brian Huseman, Amazon’s vice president of public policy.

“This (cannabis) bill offers comprehensive reform that speaks to the emergence of a bipartisan consensus to end the federal prohibition of cannabis.”

According to Forbes,

“Mace’s States Reform Act would remove cannabis from the Controlled Substances Act—it’s currently designated a Schedule I drug along with LSD and heroin— and regulate it like alcohol.

The federal government would impose a nationwide 21-year age limit for cannabis consumption, with an exception for medical use. The bill would also allow for states to make their own rules and laws around cannabis, including banning sales and use within state borders.”

As a South Carolina resident I can tell you that Mace has an uphill battle, and I suspect my home state will be the last state legalizing pot. So the closest I can get to this polarizing sector is cannabis REITs…

The Overhang

While demand appears strong in states like Maryland, marijuana remains illegal at a Federal level as a Schedule I drug under the Controlled Substances Act. That means that the government believes it to have no medical use and a high potential for abuse.

But President Biden’s proclamation on Oct. 7, 2022, included a request for the secretary of health and human services and the attorney general “to initiate the administrative process to review expeditiously how marijuana is scheduled under federal law.”

The debate of legalization continues, and on a recent earnings call , NewLake Capital Partners, Inc. ( OTCQX:NLCP ) CEO Anthony Coniglio explained (emphasis added):

“At the federal level, we see other areas of optimism and positive momentum for the industry. With the hearing on safe banking being held tomorrow and a number of cannabis-related bills introduced over the past few weeks.

While we've been subdued on the likelihood of safe passing, it is noteworthy that the most recent bipartisan bill was introduced in both the Senate and the House in a coordinated fashion and a hearing in the Senate banking committee was convened fairly quickly.

We're cautiously optimistic , but we'll know more after the hearing and if and when the bill hits the floor and other provisions are provided, then we'll be able to give a better view if we think it will actually pass.”

Innovative Industrial Properties, Inc. ( IIPR ) CEO Paul Smithers had more to say on that topic (emphasis added):

“On the federal legislation front, as you know versions of the SAFE Act were introduced again in both the House and Senate late last month. There are some reasons to be optimistic on the potential passage.

One bicameral push on its face appears to signal that this legislation could be a priority. Two, a version of SAFE has passed the House seven times now and three, the Senate Bill has 40 total sponsors, including seven Republicans.

That said, as we have stated for years now, getting a version of this bill through the process and into law continues to be daunting and will require significant time spent by Congress and an alignment of numerous sets of competing interests.”

Meanwhile, the cannabis sector is the third worst-performing REIT sector year-to-date:

Innovative Industrial Properties

Innovative Industrial Properties is an internally managed real estate investment trust (“REIT”) that specializes in cannabis related industrial properties that are leased to state-licensed operators on a triple-net basis.

Due to the triple-net lease structure, the tenant is responsible for all property costs including maintenance, taxes, insurance, and structural repairs.

IIPR’s portfolio consists of 108 properties that cover approximately 8.1 million square feet and are leased to 29 tenants with an average remaining lease term of 15.1 years. They are geographically diversified with properties located in 19 states and are the only cannabis REIT listed on the New York Stock Exchange.

Innovative Industrial Properties has excellent debt metrics with a total debt to EBITDA of 1.31x, a debt to total gross assets of approximately 12%, a debt service ratio of 16.2x, and a long-term debt to capital ratio of 13.35%.

They have a BBB+ credit rating from Egan Jones and have no debt maturities until 2024 and no significant maturities until 2026.

IIPR pays a 9.89% dividend yield that is well covered with an adjusted funds from operations (“AFFO”) payout ratio of 84.02%. From 2020 they have an average dividend growth rate of 36.68% and an average AFFO growth rate of 31.39%.

Analysts expect growth to moderate in the next several years with AFFO growth estimated to come in at 2% in 2023, -1% in 2024, and 6% in 2025. Currently the stock is trading at a P/AFFO of 8.52x, which is a significant discount to their normal AFFO multiple of 31.23x. At iREIT®, we rate IIPR a BUY.

NewLake Capital Partners

NewLake Capital Partners is an internally managed REIT that specializes in cannabis related properties including both industrial properties that are used to grow and cultivate cannabis as well as retail dispensaries.

They acquire real estate through sale-leaseback transactions and lease the properties to state-licensed cannabis operators on a triple-net basis. They own 32 properties consisting of 15 cultivation facilities and 17 dispensaries that serve 13 tenants and have a weighted average lease term (“WALT”) of 14.6 years.

Their properties encompass 1.7 million square feet and are in 12 states. The company went public in 2021 and currently trades over the counter (“OTC”).

NewLake Capital has excellent debt metrics with a debt to EBITDA of 0.2x, an interest coverage ratio of 109.31x, and a long-term debt to capital of 0.52%.

To put their leverage in perspective, as of the end of the first quarter, NLCP had a market capitalization of $276 million, $41.5 million of cash on hand, and only $2 million of outstanding debt. In addition to their cash, they have $89 million available to them under their revolving credit facility for $130.5 million in total liquidity.

In the company’s short existence, they have delivered an average adjusted funds from operations ("AFFO") growth rate of 22.38% and an average dividend growth rate of 234.88%. Both growth metrics are expected to normalize with AFFO growth projected at 6% and dividend growth projected at 6.25% in 2023.

Currently NLCP is trading well below their normal AFFO multiple with a current P/AFFO of 6.88x compared to their normal AFFO multiple of 16.48x. At iREIT®, we rate NewLake Capital Partners a Spec BUY.

AFC Gamma, Inc. ( AFCG )

AFC Gamma is a mortgage REIT (“mREIT”) that specializes in originating loans for cannabis related facilities. However, they have recently expanded their investments to other commercial real estate property types including industrial, retail, office, hotel, life science, and multifamily properties.

Prior to their expanded investment guidelines they exclusively issued first lien mortgage loans to cannabis operators, but now offer first and second lien loans that are secured by multiple types of commercial real estate.

Over the past 8 quarters, AFCG’s distributable earnings covered the dividend and had a dividend payout ratio of 98.24% in the first quarter of 2023. From 2021 to the first quarter of 2023, AFCG either raised or maintained their dividend, but recently announced a dividend cut (which we predicted would happen).

On June 15, 2023, AFCG declared a quarterly dividend of $0.48 per share for the quarter ending June 30, 2023. The quarterly dividend of $0.48 comes to an annual run rate of $1.92 per share, which represents a dividend cut of approximately 14%.

AFC Gamma currently pays a 14.45% dividend yield and trades at a price to adjusted operating earnings (“P/E”) of 5.55x, which is well below their normal P/E of 9.28x, however we are cautious on the mREIT given the recent dividend cut and strategic shift in their investment strategy.

When the company was formed in 2020 they had a sole focus on first mortgage loans issued for cannabis related properties, but just 2 years later they announced their expanded investment guidelines to include bridge loans and other types of subordinate loans as well as other property types acting as collateral. At iREIT®, we rate AFCG a SELL.

Chicago Atlantic Real Estate Finance, Inc. ( REFI )

Chicago Atlantic Real Estate is an externally managed mREIT that specializes in issuing senior secured loans to state-licensed cannabis operators. While REFI’s current portfolio primarily consists of senior loans for cannabis related properties, they expect to also issue loans or invest in companies outside of the cannabis space if doing so provides attractive return characteristics.

As of their most recent update, their portfolio has a 41% weighted average loan to enterprise value and a weighted average collateral coverage of 1.6x.

During the first quarter of 2023, REFI generated net income of $10.6 million, up from $7.3 million in the prior quarter. Distributable earnings per share came in at $0.62 vs $0.57 in the prior quarter for a quarter-over-quarter increase of 8.7%. The first quarter dividend of $0.47 per share represented a dividend payout ratio of 75.8% when based on distributable earnings.

Chicago Atlantic Real Estate pays an 11.77% dividend yield and currently trades at a P/E of 7.13x, which compares favorably to their normal P/E of 9.25x. REFI is a young company, having filed their IPO in December of 2021, but since that time they have had an adjusted operating earnings growth rate of 18.56%.

Analysts expect earnings growth to moderate with projections of 14% and 2% earnings growth in the years 2023 and 2024 respectively.

From the chart below, it appears as if REFI cut its dividend from $2.10 to $1.88 per share, but this is due to a special dividend of $0.29 per share paid in the fourth quarter of 2022.

When excluding the special dividend, REFI has maintained their annual dividend rate of $1.88 per share, and analysts expect the dividend to increase to $2.05 per share in 2024. At iREIT®, we rate REFI a Spec BUY.

Power REIT ( PW )

Power REIT is an internally managed diversified REIT that invests in controlled environment agriculture, (greenhouses), transportation, and energy infrastructure including solar.

PW acquires real estate and typically leases their properties on a long-term, triple net basis. While they have investments in multiple property types, PW is focused on increasing its exposure to greenhouse properties that grow food and cultivate cannabis.

As of the end of 2022, PW’s portfolio consisted of 112 miles of railroad infrastructure that is owned by a subsidiary, around 600 acres of fee simple land that is leased to multiple solar power projects, and approximately 260 acres of land with roughly 2.2 million square feet of greenhouses.

Since 2019, PW has expanded their focus on greenhouse properties that create optimized growing environments for indoor crops, including cannabis. They target greenhouses that use 70% less energy than indoor growing facilities and 95% less water than outdoor growing.

No one has written on Power REIT in 2023:

The last article was on October 17, 2022.

iREIT® dropped coverage on Power REIT as the company became a microcap (~$5 million market cap currently). Shares traded as high as $78.00 in January 2022 and now trade at an abysmal $1.52 per share.

iREIT® does not cover the company, and I’ve never seen a P/E multiple less than 1x:

In Closing…

As the title to my article suggests, the Cannabis REITs Have Gone To Pot. Meanwhile, the dividend yields are growing like a weed, averaging 13%.

As the cannabis debate rolls on, I still own shares in IIPR, NLCP, and REFI, although I’m maintaining modest exposure, recognizing that the impact on federalization remains as a risk.

We’ve argued in the past that there are synergies with IIPR and NLCP in terms of M&A, and of course NLCP benefits from IIPR’s NYSE listing.

Also, we see value in NLCP merging with REFI, which means that NLCP would have to become a mortgage REIT, which is how REFI is able to list on NASDAQ.

We’re not sure about PW and AFCG’s future…

We like the management teams at IIPR, NLCP, and REFI and that’s a big reason I own shares in these REITs.

Right now, we like NLCP and REFI based on their valuation and future growth prospects.

As always, thanks for reading and I look forward to your comments.

For further details see:

Cannabis REITs Have Gone To Pot